Morgan Stanley, Financial Stocks Plunge on 'Quitaly' Fears

Morgan Stanley (MS) , JPMorgan Chase & Co. (JPM) , Goldman Sachs Group Inc. (GS) , Citigroup Inc. (C) and Bank of America Corp. (BAC) all fell more than 3% Tuesday, leading a rout of financial stocks as Italy's escalating political crisis threatens its place in the European Union.

Morgan Stanley dropped 5.74%, the day's largest loss among financial stocks and the second biggest loser among the S&P 500 . JPMorgan Chase dropped 4.20%, Goldman Sachs fell 3.4%, Citigroup lost 4% and Bank of America slipped by 3.6%. The Dow Jones Industrial Average fell more than 1.6% in its largest decline since April 6 as banking investors pulled out of Italy.

"The desire for (either the EU or the ECB) to intervene may not be very pronounced yet," said Holger Schmieding, chief economist at Berenberg. "The current selloff could be a salutary lesson for some of those politicians in Italy who are playing with fire by questioning the rule of the euro and thus - implicitly - the commitment to stay in the euro."

Investors sold the euro, pushing the U.S. dollar up 0.63% to a 10-month high against the single currency as the latter plunged to $1.15, its lowest this year. Italian bonds also sustained losses as investors demanded higher yields to purchase more debt from what is already the world's third most indebted country. Yields on Italian 10-year bonds jumped 17.88 percentage points to 3.178%.

Although Italy is no stranger to political crisis - it has had 64 governments since World War II - the possibility of a new government in favor of 'Quitaly' has forced investors to question the stability of the European Union.

"The more recent bout of political turmoil spanning across a number of member countries coupled with a clear loss of economic momentum in the region has investors questioning the sustainability of the recovery and the future of the bloc," Stifel Nicolaus chief economist Lindsey Piegza told CNBC.

American banks faced similar losses in the 2010 Eurozone crisis as Greece was forced to adopt austerity measures to avoid being forced out of the Eurozone. Italy, however, is the EU's third largest economy and accounts for 15 percent of its total GDP, compared with Greece's 1.2 percent.